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Ok, .iso files work for movie DVD's and not for Xbox games, because the game engine cuts off anything media center was doing. The way I understand it, XBMC kind of ports the game you select back to the native Xbox engine (that engine can't really be emulated well). So no other XBMC functions are available while you game. Running an .iso is one of those functions.
You need to extract that .iso to a folder on the Xbox, probably through FTP. You can mount the .iso on your PC using Daemon Tools, etc., and then FTP all the contents to your Xbox. It might be easier though, to use a program called Craxtion to open the .iso and extract it to your Xbox in a folder you specify. If you have a stock hard drive, one or two games will usually max it out. I suggest making a new folder on your E drive called Games if you haven't already. I think that's a default source in XBMC My Programs. So, get all all the files and folder to the Xbox hard drive, and it will usually play them ok.
Hope that makes sense. It's early here:)
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